Why is Russia and the Roubles pegged to Gold?

Why is Russia and the Ruble pegged to Gold

Surprisingly, the Bank of Russia, Russia’s central bank has announced a fixed price to buy gold with roubles. A gram of gold will cost RUB5,000 (PS45.12), which is the highest price a country’s currency has ever been quoted in “gold parity” since 1999, when Switzerland stopped doing it.

The world’s largest powers used gold parity to facilitate international trade payments during the golden age of the 19th and 20th centuries. This was also true during the Bretton Woods period, from 1944 to 1971. It was then that US President Nixon removed the link between the US dollar and gold.

The new arrangement between Putin and the US is expected to be in place from March 28 through June 30. This is the latest in a string of rouble-related moves made by Russia. It follows the March 23 announcement that they would accept only roubles to pay for European gas, instead of euros or US dollars. It was my prediction that Russia would extend its oil policy, but now it has signaled an intention to make this policy apply to all commodities it exports, including wheat, nickel and enriched uranium.

These moves are designed to increase the value of the rouble in the forex market and to improve its credibility. However, it fits in with long-standing efforts by Russia and China in order to undermine the US dollar’s position as the global reserve currency.

The chart below shows that the rouble fell in February and March after western sanctions were imposed to stop Russia’s invasion in Ukraine. It looks like the collapse is occurring because the chart shows the ratio of the number of rubles to the US dollars, rather than the reverse.

The rouble did recover somewhat after the huge drop. This is what happens in such situations, and it’s known in the literature “exchange rate overshooting”. The currency strengthened even more after the announcement of roubles for gas (no matter how serious and implementable the plan – there has been resistance so far to Putin’s new rules).

The currency strengthened to RUB83 against the dollar in response to the announcement about gold. Ronan Manly, precious metals analyst, stated that this is reasonable considering the current market price for a gram (PS47.20) of gold. This is very close to Putin’s announcement of 1 gram gold equals RUB5,000. This effectively creates an exchange rate based on gold of RUB81-1.
Systems that were based on gold before now

Let me give you an historical example to show the similarities between the Bretton Woods and gold standard. The Coinage Act of 1816 in the UK fixed the value of sterling at 113 grams of pure gold. While the US Gold Standard Act of 1900 set the dollar’s value at 23.22 grains of gold, the US Gold Standard Act of 2000 determined that the US should keep its value at 23.22 grains of gold. The two acts combined implied a gold parity official exchange rate of PS1 = US$4.87.

The situation was similar in the post-war Bretton Woods period. 1 ounce of Gold was valued at US$35 and all other currencies were fixed and convertible into the US Dollar. As a means of making money credible, gold was the center of the system.

Surprisingly, the Bank of Russia, Russia’s central bank has announced a fixed price to buy gold with roubles. A gram of gold will cost RUB5,000 (PS45.12), which is the highest price a country’s currency has ever been quoted in “gold parity” since 1999, when Switzerland stopped doing it.

The world’s largest powers used gold parity to facilitate international trade payments during the golden age of the 19th and 20th centuries. This was also true during the Bretton Woods period, from 1944 to 1971. It was then that US President Nixon removed the link between the US dollar and gold.

The new arrangement between Putin and the US is expected to be in place from March 28 through June 30. This is the latest in a string of rouble-related moves made by Russia. It follows the March 23 announcement that they would accept only roubles to pay for European gas, instead of euros or US dollars. It was my prediction that Russia would extend its oil policy, but now it has signaled an intention to make this policy apply to all commodities it exports, including wheat, nickel and enriched uranium.

These moves are designed to increase the value of the rouble in the forex market and to improve its credibility. However, it fits in with long-standing efforts by Russia and China in order to undermine the US dollar’s position as the global reserve currency.

The chart below shows that the rouble fell in February and March after western sanctions were imposed to stop Russia’s invasion in Ukraine. It looks like the collapse is occurring because the chart shows the ratio of the roubles to US dollars, rather than the reverse.

The rouble did recover somewhat after the huge drop. This is what happens in such situations, and it’s known in the literature “exchange rate overshooting”. The currency strengthened even more after the announcement of roubles for gas (no matter how serious and implementable the plan – there has been resistance so far to Putin’s new rules).

The currency strengthened to RUB83 against the dollar in response to the announcement about gold. Ronan Manly, precious metals analyst, stated that this is reasonable considering the current market price for a gram (PS47.20) of gold. This is very close to Putin’s announcement of 1 gram gold equals RUB5,000. This effectively creates an exchange rate based on gold of RUB81-1.
Systems that were based on gold before now

Let me give you an historical example to show the similarities between the Bretton Woods and gold standard. The Coinage Act of 1816 in the UK fixed the value of sterling at 113 grams of pure gold. While the US Gold Standard Act of 1900 set the dollar’s value at 23.22 grains of gold, the US Gold Standard Act of 2000 determined that the US should keep its value at 23.22 grains of gold. The two acts combined implied a gold parity official exchange rate of PS1 = US$4.87.

The situation was similar in the post-war Bretton Woods period. 1 ounce of Gold was valued at US$35 and all other currencies were fixed and convertible into the US Dollar. As a means of making money credible, gold was the center of the system.
No more free-floating rubble. Cloudy Design

Russia must follow certain rules when attaching the ruble to a gold standard. Russia should be open to exchanging gold for roubles, with anyone who wishes to.

This is what the US did in the Bretton Woods era and it led the system to collapse. As US spending rose to wage the Vietnam War, dollar holders became more anxious about the dollar’s worth and tried to exchange it for precious metals.

Nixon made the unilateral decision to end conversion out of fear that the US would run low on gold. This would have ruined the credibility of dollar. The world has been moving to floating exchange rates since that time. As the value of world currencies has become less dependent on the dollar, the price of gold has steadily increased. In effect, the system was supported by an agreement that the Americans made in the 1970s to purchase oil from Saudi Arabia and provide military support in return for dollars used to buy US government bonds.

Russia’s problem is that it may soon find itself in a similar position to the US around 1971 if it decides to exchange its roubles for a gold. Wars are an unusual state of affairs that are fraught with uncertainty. It is impossible to predict the future and markets can be prone to react to any new developments, especially in the short-term. Many investors may decide to withdraw their gold from the central banks if confidence in the ruble falls again. This could prove extremely dangerous for Moscow.

It is directly related to the demand for Russian energy that Russia maintains a fixed rate for gold. If the west is unable to gradually replace its dependence on Russia’s oil, gas and other resources, then the demand for roubles will be a key factor in keeping the currency stable (especially if it does have to pay in roubles).

The rouble, along with the entire Russian economy, could plummet dramatically if politicians heed economists and stop importing Russian oil, gas and other commodities. Even though this could cause more pain and prices, it might be the best and most effective way to get Russia to end the war.